Managing debt as you approach retirement

If retirement is on the horizon and you plan on buying a retirement home in the next few years, you may want to consider accelerating the purchase while you’re still generating a high income and can qualify for preferred terms on a conventional mortgage loan. This will afford you the flexibility to take out a loan on your primary residence and use those funds to complete the purchase.

Private Wealth Advisors Michelle Mayer and Chelsea Botta often have clients approach them with plans to purchase a new house with an all-cash offer. “Even though these families certainly have the means to do so, it’s not necessarily the smartest move,” they note. “We had this precise situation occur a few years ago when 20-year mortgage rates were somewhere around 2.5%. Not only could the couple benefit from the mortgage interest deduction, but the income generated by keeping assets in their portfolio would more than cover the monthly mortgage payment without requiring the liquidation of any investments.”

With competition for residential properties in highly desirable markets remaining fierce, it’s true that an all-cash offer may make the difference between a seller accepting or rejecting your bid. But an equally quick closing can be achieved by leveraging a pre-qualified traditional mortgage — leaving your portfolio assets free to continue growing.

Given the performance of the market over time, the opportunity cost of using invested funds to pay off a low-rate mortgage may not be the best idea. You need to look at both sides of the balance sheet. For example, suppose you currently have a $500,000 mortgage with a 3% interest rate, as well as a $2.5 million diversified portfolio that generates an average annual return of 7%.

• If you liquidated $500,000 from your investment portfolio to pay off the mortgage, you would save around $15,000 per year in interest payments — but much of that savings would likely be eaten up by capital gains taxes on the sale of assets.
  
  
• By keeping the $500,000 in your portfolio, however, you can expect to earn an additional $35,000 in annual returns (7% of $500,000) with no taxable transactions.

For many wealthy individuals and couples, the lion’s share of their net worth is tied up in home(s), retirement accounts and business interests. These individuals may have a net worth of $3 to 5 million, yet very little in the way of liquidity.

“I’ve never been a big fan of liquidating significant portfolio assets to fund a large purchase,” notes Beckwith. “If we can average an 8% return on assets and we can borrow money at 5%, and we know it’s only going to be for a few years — I’ll generally recommend borrowing to fund those purchases. It’s the reason why some of my wealthiest clients are still carrying mortgages on their second and third homes.”

Rather than trying to unwind investments that could trigger significant capital gains taxes, the thoughtful use of lending can be a markedly more advantageous way to fund major purchases. For example, the following represent three instances where assuming debt may be preferable to liquidating your investment positions:

• For shorter-term lending needs, such as a bridge loan to purchase a new home while you sell your existing home, a securities-backed solution such as the Loan Management Account (LMA account) from Bank of America can offer a quick and easy solution. Although rates may be higher than other types of loans, a securities-backed loan avoids property appraisals so it can be implemented quickly and easily. Then, once the second property sale is completed, you simply repay the loan. Alternatively, you could opt to use a Home Equity Line of Credit (HELOC) or a Custom Lending solution to leverage existing assets as collateral for a flexible line of credit to maintain your current wealth management strategy.
  
  
• If you expect debt to be repaid by some definite future liquidity event (such as the sale of a closely-held business, a stock option exercise, or a lump sum pension payout), then taking it on now and carrying it into retirement may be far more advantageous than selling off portfolio holdings.
  
  
• Only when there’s no other clear, viable avenue for paying down the debt should you consider liquidating portfolio assets, given the resulting loss of future growth potential as well as the possible tax ramifications.

You should be aware, however, that securities-based loans carry some risks and may not be appropriate for all investors. A significant decline in the value of your collateral assets could require depositing additional funds or securities to avoid a collateral maintenance call and/or forced sale of assets. And you potentially could lose more funds than are held in the collateral account. Therefore, make sure to review all loan agreement documents and disclosures carefully and consult with your tax and legal advisor before borrowing.

By strategically leveraging lending and debt to fund your major expenditures, you have an opportunity to minimize or eliminate any capital gains taxes that the sale of portfolio holdings might trigger. Additionally, it’s important to note that any assets you are able to retain until you die may get a "step up" in basis. This means that your beneficiaries take ownership at the assets' market value at the time of your death, not the original cost basis, and can sell the assets without paying taxes on the earlier growth.¹

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